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Friday, June 24, 2011

Greece's crisis - perhaps a solution after all?

The steps taken by EU-elites so far can be summarized as follows: “We – EU/ECB/Central Banks – use Greece’s balance sheet and tax payers’ money to bail out our own banks and we call that “Financial Help for Greece’”.

An economy which is down and out does not need that kind of financial help as much as it needs an Economic Development Plan (not unsimilar to the then Marshall Plan).

Contrary to the assertions by EU-elites, it is not the sovereign debt which is Greece’s greatest problem. Her greatest problem is the banking sector which mirrors how much money flowed into Greece since the Euro and how that money was spent (excessive imports and massive capital flight in the last 2 years).

Greece’s gross foreign debt increased between 2001-2010 from 121 billion EUR to 410 billion EUR. That is on average 30 billion EUR which flowed into the Greek economy annually. Less than half of that was used by the state. Of the total foreign debt, “only” 190 billion EUR relate to the state; the banking sector accounts for 202 billion EUR.

Those 410 billion EUR of foreign savings will have to remain in Greece for a long time and every year an additional 20-25 billion EUR will be needed to finance the economy (this is already assuming that there will be no debt installments, only modest interest payments and no capital flight). Why will Greece need so much Fresh Money? Because Greece needs growth and domestic savings do not suffice by far to finance that growth.

A return to the Drachmae would overall be the worst evil of all. Thus, Greece should hold on to the Euro but simulate a situation as though she had returned to the Drachmae. That, of course, will violate certain EU-freedoms (free movement of goods and capital) but there is no other way to make it work. It is an emergency and emergencies require emergency legislation.

Assuming that the Drachmae would immediately devalue by 30-40%, one has to take measures so that imports become 30-40% more expensive overall. That means special taxes on imports ranging from 100% on luxury goods to 0% on top-priority goods.

To make exports cheaper, one would have to introduce wage/price controls but such controls have never worked anywhere on a sustained basis. The alternative is to establish Free Trade Zones where internationally competitive conditions are put in place (China is still being ruled by Communism but in parts of the Chinese economy pure capitalism reigns). Over the years, the conditions in the FTZ will, if they work successfully, rub off on the rest of the economy.

New production must be started up in these FTZ and foreign capital investment must be attracted for that. How should that work in the present situation?

One would produce those products which are presently being imported but which could just as well be produced in Greece if the economic framework were „right“. The foreign investor must be offered very attractive, internationally competitive conditions. A new constitutional Foreign Investment Law must assure the foreign investor that these conditions will remain in place. And the potential for foreign investment would be the enormous funds which wealthy Greeks hold in foreign bank accounts. Why should a wealthy Greek prefer earning 2% in Switzerland when he could earn a multiple thereof in Greece?

In a way, the foreign investor finds an economic Nirwana: there is already a market for the products which he will produce and he can produce them at competitive conditions.The EU should guarantee the political (not the economic!) risk of such foreign investments.

Last but not least, official capital flight (via bank accounts) must be stopped by imposing restrictions on capital transfers abroad.

To develop such an Economic Development Plan, one will need the best brains not only of Greece but also from Europe. The much simpler challenge is to solve the foreign debt problem. For that, one needs a few hundred people in a conference hall who agree on something.

Greece should offer her creditors to prepay the entire 410 billion EUR (no haircut!). In the absence of the necessary cash, Greece should propose to pay in a different form, such as: 20-year bonds for 50% of that debt; 10-year bonds for 30% of that debt and 5-year bonds for 20% of that debt. During the first 5 years, 2/3 of the interest would be capitalized to preserve cash. And the required Fresh Money would be in a Senior Position.

Banks would have to write-down their Greek loans to their value in the secondary market. New EU-legislation should allow the banks to stretch those write-downs over 5 years.

Should the Economic Development Plan fail, then those bonds will become rather worthless. If not, then those bonds would regain value (even 100% could not be totally ruled out if Greece, after several years, regains confidence in capital markets).

Should the Economic Development Plan work, then the banks could dissolve their loan loss reserves and they would have windfall profits. The governments should tax those windfall profits at 100% and pass that money on to Greece as a “present”. A present for having managed to become a value-generating member of the EU and in the process contributing to the saving of the European Project. That would be the incentive for Greece to bear the painful burden of the restructuring of her economy.

The most important thing is that all measures maintain the character of being „voluntary“ and „mutually consented“. No smart lawyer should be able to construe an Event of Default.

And, of course, domestic savings would have to be frozen during those negotiations in order to avoid a run on the banking system.